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61sT  Congress  1 
2d  Session      j 


SENATE 


f  Document 
I    No.  569 


NATIONAL  MONETARY  COMMISSION 


Bank  Acceptances 


By 


LAWRENCE   MERTON  JACOBS 


€ 


Washington  :  Government  Printing  Office  :  1910 


61ST  Congress  \  ct7t>j  att?  /  Document 

2d  Session      )  SENATE  j     No.  569 


NATIONAL  MONETARY  COMMISSION 


Bank  Acceptances 


By 


LAWRENCE   MERTON  JACOBS 


Washington  :  Government  Printing  Office  :  1910 


\A& 


NATIONAL  MONETARY  COMMISSION. 


Nelson  W.  Ai,drich,  Rhode  Island,  Chairman. 
Edward  B.  Vreeland,  New  York,  Vice-Chairman. 


Julius  C,  Burrows,  Michigan. 
Eugene  Hale,  Maine. 
Philander  C.  Knox,  Pennsylvania. 
Theodore  E.  Burton,  Ohio. 
Henry  M.  Teller,  Colorado. 
Hernando  D.  Money,  Mississippi. 
Joseph  W.  Bailey,  Texas. 


John  W.  Weeks,  Massachusetts. 
Robert  W.  Bonynge,  Colorado. 
Sylvester  C.  Smith,  California. 
Lemuel  P.  Padgett,  Tennessee. 
George  F.  Burgess,  Texas. 
Arsene  p.  Pujo,  Louisiana. 
Arthur  B.  Shelton,  Secretary 


A.  Piatt  Andrew,  Special  Assistant  to  Commission. 


BANK   ACCEPTANCES. 

By  Lawrence  Merton  Jacobs. 

The    fundamental    difference   between    European    and 
American    banking    has    its    origin    in    the    dissimilarity 
between  the  evidences  of  indebtedness  which  lie  behind 
the  item  of  loans  and  discounts.     It  is  most  strikingly  evi-  ^ 
denced  in  the  fact  that  time  bills  of  exchange  form  a  con-  / 
siderable  proportion  of  the  resources  of  the  great  banks  of/ 
London,  Paris,  and  Berlin,  whereas  (the  assets  of  leadins 
New  York  banks  are  largely  based^on_stocks_an  j  bondsN 

Of  the  bills  of  exchange  in  which  are  employed,  either 
through  loans  or  discounts,  the  funds  of  European  banks, 
an  essential  part  consists  of  what  are  known  as  bankers' 
bills — that  is,  bills  drawn  on  bankers  and  accepted  by 
them  on  behalf  of  customers  in  accordance  with  arrange- 
ments previously  made.  They  are  bills  in  exchange  for 
which,  by  sale  to  a  broker  or  by  discounting  at  a  bank, 
bankers*  customers  or  those  to  w^hom  they  are  indebted 
may  secure  immediate  credit.  In  some  instances  it  is 
arranged  that  the  customers  themselves  shall  draw  the 
bills  and  in  others  that  the  bills  shall  be  drawn  by  third 
parties  for  their  account.  In  granting  the  accommodation 
the  obHgation  that  the  bankers  take  upon  themselves  is 
that  they  will  accept  the  bills  upon  presentation.  This 
acceptance  consists  in  the  bankers  WTiting  across  the  face 
of  the  drafts  the  word  "Accepted,"  adding  their  signature 
and  the  date.  It  is  in  the  nature  of  a  certification  that 
the  bills  will   be  paid   at   maturity — that   is,  a  specified 


211275 


National     Monetary     Commission 

number  of  days  or  months  from  the  date  appearing  in  the 
acceptance,  or  three  days  later  if  grace  is  allowed,  as  in 
England.  When  a  banker  grants  accommodation  to  a 
customer  by  means  of  an  acceptance,  he  may  secure  him- 
self in  various  ways.  Ordinarily  a  banker  accepts  a  cus- 
tomer's draft  merely  upon  his  general  responsibility,  the 
banker's  risk  being  m.uch  the  same  as  if  he  had  discounted 
the  customer's  note  running  a  certain  length  of  time. 
Where  the  customer  is  an  importer,  the  banker  ordi- 
narily accepts  the  drafts  upon  the  delivery  to  him  of  the 
documents  covering  the  shipment,  which  documents  he 
then  turns  over  to  his  customer  against  a  trust  receipt. 
When  a  credit  of  this  kind  is  opened,  the  usual  practice  is 
for  the  banker  to  require  the  signature  of  a  form  containing 
an  agreement  to  hold  him  harmless  for  accepting  the  bills, 
to  place  him  in  funds  sufficient  to  pay  off  the  bills  three 
days  prior  to  their  maturity,  and  to  pay  him  a  commission 
on  the  transaction,  this  commission  varying  according  to 
the  length  of  time  the  bills  are  to  run  and  the  financial 
standing  of  the  customer.  The  cost  of  the  accommoda- 
tion to  the  customer  is  this  commission  plus  the  prevailing 
rate  of  discount  for  bankers'  bills. 

In  the  United  States  the  national  bank  act  does  not 

\    permit    banks    to    accept    time    bills    drawn    on    them. 

'    Although    the    act    does    not    specifically    prohibit    such 

acceptances,  the  courts  have  decided  that  national  banks 

have  no  power  to  make  them.     This  restriction  has  had 

a  very  considerable  influence  upon  the  development  of 

M    banking  in  this  country.     For  some  time  after  the  passage 

of  the  national  bank  act,  merchants  and  manufacturers 

provided   themselves   with   funds   by    discounting   their 


Bank  Acceptances  in    United  States 

promissor}^  notes  with  their  local  banker.  Gradually, 
however,  many  concerns,  finding  that  their  needs  were 
outstripping  the  banking  accommodation  which  they 
could  secure  in  their  immediate  vicinity,  came  to  place 
their  notes  in  the  hands  of  brokers  who  in  turn  disposed 
of  them  to  such  bankers  as  possessed  greater  surpluses 
than  they  could  satisfactorily  invest  at  home.  It  is  this 
method  of  borrowing  which  is  now  largely  employed.  In  , 
other  words,  the  prohibition  of  bank  acceptances  hassled 
to  the  creation  of  a  vast  amoimt  of  promissory  notes 
instead  of  time  bills  of  exchange.  The  difference  between 
these  two  classes  of  instruments  accounts  to  a  great 
extent  for  the  difference  between  European  and  Ameri- 
can banking.  In  the  case  of  time  bills  of  exchange 
drawn  on  and  accepted  by  prime  banks  and  bankers  there  \^ 
is  practical  uniformity  of  security.  In  the  case  of  our 
promissory  notes  or  commercial  paper  there  is  no  such 
uniformity,  the  strength  of  the  paper  depending  on  the 
standing  of  miscellaneous  mercantile  and  industrial 
concerns. 

It  is  this  uniformity  of  security,  on  the  one  hand,  which 
makes  possible  a  public  discount  market;  it  is  the  lack  of 
it  in  single-name  paper  which  makes  such  a  market 
impossible.  As  a  result,  we  have  great  discount  markets 
in  London,  Paris,  and  Berlin,  and  none  in  New  York.  In 
European  centers  the  discoiuit  rate  is  the  rate  upon  which 
the  eyes  of  the  financial  community  are  fixed.  In  New 
York  it  is  the  rate  for  day-to-day  loans  on  the  Stock 
Exchange.  The  advantage  in  character  of  the  one  rate 
over  the  other  clearly  indicates  an  important  advantage 
of  European  banking  systems  over  our  own.     In  the  first 

5 


National    Monetary     Commission 

place,  the  European  discount  rate  bears  a  very  direct 
relation  to  trade  conditions.  Its  fluctuations  depend 
primarily  on  the  demand  for  and  supply  of  bills  which 
owe  their  origin  to  trade  transactions,  as  balanced  against 
the  demand  for  and  supply  of  money.  If  trade  is  active 
the  supply  of  bills  becomes  large,  rapidly  absorbing  the 
loanable  funds  of  the  banks.  As  these  surplus  funds 
becomxe  less  and  less  banks  are  unwilling  to  discount  except 
at  advanced  rates.  If  trade  is  slack,  less  accommodation 
from  bankers  in  the  way  of  acceptances  is  required,  bills 
become  fewer  in  number,  the  competition  for  them  in  the 
discount  market  more  keen,  and  the  rate  of  discount  de- 
clines. Low  rates  are  an  incentive  to  business  and  advanc- 
ing rates  act  as  a  natural  check.  The  New  York  call-loan 
rate,  on  the  other  hand,  bears  only  an  indirect  relation  to 
trade  conditions.  Its  day-to-day  fluctuations  register 
mainly  the  speculative  and  investment  demand  for  stocks. 
Low  rates,  instead  of  being  an  incentive  to  the  revival  of 
trade,  are  rather  made  the  basis  for.  speculative  operations 
in  securities. 

The  striking  difference,  however,  between  European 
discount  rates  and  the  New  York  call-loan  rates  is  that  the 
former  are  comparatively  stable  and  the  latter  subject  to 
most  violent  oscillations.  Foreign  discount  rates  as  bank 
reserves  become  depleted  advance  by  fractions  of  i  per 
cent.  In  New  York  the  money  rate  advances  on  occasion 
ID  per  cent  at  a  time,  mounting  by  leaps  and  bounds  from 
20  per  cent  to  100  per  cent  in  times  of  stress. 
y  There  are  two  principal  reasons  for  the  stability  of  for- 
eign discount  rates.  In  the  first  place,  trade  expands  and 
contracts  gradually,  so  trade  bills  multiply  or  diminish  in 

6 


Bank  Acceptances  in    United  States 

number  little  by  little,  producing  a  gradual  increase  or 
decrease  in  the  demand  for  money.  In  the  second  place, 
discount  rates  are  steady  because  there  is  a  free  movement 
of  funds  between  the  countries  possessing  great  discount 
markets.  Between  London  and  Paris  money  flows  as  the 
balance  of  indebtedness  changes,  modified  by  the  discount 
rates  at  the  respective  centers.  If  France  owes  England 
more  than  England  owes  France,  money  will  tend  to  flow 
from  Paris  to  London  in  settlement  of  this  balance  of 
indebtedness.  If  the  London  discount  rate  is  higher  than 
that  of  Paris,  the  movement  will  be  accentuated  by  the 
movement  of  French  funds  to  London  for  investment  in 
sterling  bills  of  exchange — that  is,  in  bills  drawn  on  and 
accepted  by  prime  English  banks  and  bankers.  If  the 
Paris  discount  rate  is  higher  than  that  of  London,  there  will 
be  a  natural  offset  to  the  tendency  of  funds  to  move  to 
London  in  settlement  of  this  balance  of  indebtedness. 
Briefly,  money  seeks  investment  in  those  centers  where 
the  discount  rates  are  highest.  If  the  discount  rate  in 
Paris  is  iK  per  cent  and  2^  per  cent  in  London,  Paris 
bankers  remit  funds  to  London  for  investment  in  sterling 
bills.  This  increases  the  supply  of  money  competing  for 
bills  in  London  and  forces  the  discount  rate  downward. 
At  the  same  time  the  drain  of  funds  from  Paris  results  in 
lessening  the  competition  for  bills  in  that  center  and  the 
Paris  discount  rate  rises.  Thus  it  is  that  funds  freely 
move  to  and  fro  between  London,  Paris,  Berlin  and  Am- 
sterdam, an  exact  equality  in  rates  being  prevented 
largely  by  the  fact  that  the  discount  markets  in  these 
cities  differ  in  size  and  that  there  is  not  in  each  an  equally 
free  market  for  gold.     For  example,  the  Paris  discount 


National    Monetary     C  ommis  s  io 


n 


market  is  broader  than  that  of  Amsterdam,  and  there  is 
consequently  less  risk  in  exchange  in  forwarding  funds  to 
Paris  for  investment  than  to  Amsterdam.  That  the  Paris 
discount  rate  should  rule  somewhat  lower  than  that  of 
Amsterdam  is  accordingly  natural.  Sterling  bills,  more- 
over, are  favored  above  German  bills  because  London  pos- 
sesses a  freer  market  for  gold  than  does  Berlin — that  is, 
a  holder  of  credit  in  London  can  count  on  being  able  not 
only  to  convert  it  into  gold,  but  to  withdraw  the  gold, 
whereas  artificial  restrictions  are  sometimes  placed  on  the 
withdrawal  of  gold  from  Germany.  In  consequence, 
apart  from  any  consideration  as  to  relative  size  of  the  two 
money  markets,  there  is  a  tendency  for  funds  to  remain 
in  or  to  move  to  London  even  when  the  Berlin  discount 
rate  is  slightly  higher. 

"^  There  are  likewise  two  principal  reasons  for  the  insta- 
bility of  the  money  rate  in  New  York.  The  first  is  that 
the  demand  for  loans  for  the  purpose  of  speculative  opera- 
tions in  stocks  does  not  increase  gradually.  A  few  weeks 
at  most  are  sufficient  for  a  large  speculative  movement  to 
develop.  At  the  same  time  the  profits  in  successful  stock 
speculation  are  so  great  compared  with  those  in  trade 
that  the  matter  of  whether  the  call  rate  is  6  per  cent  or 
IO  per  cent  is  relatively  unimportant.  So  it  is  that  only 
very  sharp  and  very  considerable  advances  in  the  call 
rate  are  effective  in  checking  the  demand  for  money. 
The  second  reason  is  that  an  advance  in  the  call  rate 
above  the  level  of  foreign  discount  rates  does  not  serve 
directly  to  attract  funds  from  Europe.  The  continuance 
of  high  rates  can  not  be  depended  upon,  and  furthermore, 
while  London  bankers,  for  example,  may  be  willing  to 

8 


Bank  Acceptances  in   United  States 

loan  money  to  finance  speculative  movements  at  home, 
to  make  advances  for  similar  purposes  abroad  is  quite 
another  matter.  In  fact,  the  higher  the  call  rate  is  the 
less  the  European  banker  is  inclined  to  lend  his  money  in 
the  New  York  market.  New  York  is  in  a  class  by  itself. 
Without  bank-accepted  bills  it  can  have  no  discount 
market.  Without  a  discount  market  funds  can  not  move 
to  it  as  they  do  between  the  financial  centers  of  Eiu-ope, 
because  there  are  no  bank-accepted  bills  in  which  foreign 
banks  can  invest.  Our  commercial  paper  is  not  suitable. 
Foreign  banks  will  not  purchase  it  because  they  are  not 
acquainted  with  or  sure  of  the  rating  of  miscellaneous 
mercantile  establishments  and  because  such  paper  could 
not  be  readily  disposed  of  in  case  it  became  necessary  or 
profitable  to  w^ithdraw  funds  from  New  York  for  remit- 
tance elsewhere. 

>L  The  weakness  of  our  banking  system  as  compared  with 
the  systems  of  Europe  may  very  certainly  be  attributed 
in  part  to  the  omission  of  the  bank  act  to  permit  bank 
acceptances.  It  is  a  weakness,  furthermore,  which  in- 
volves the  country  in  serious  economic  loss.  Without  a 
national  discount  market,  the  great  majority  of  our  mer- 
chants and  manufacturers  are  compelled  to  confine  their 
borrowings  to  American  capital,  either  through  the  dis- 
counting of  their  paper  with  their  local  banks  or  through 
its  sale  to  note  brokers.  All  but  the  strongest  and  largest 
are  practically  excluded  from  the  benefits  of  foreign  com- 
petition for  their  paper.  Aside  from  the  great  concerns 
with  international  ramifications,  which  are  able  to  arrange 
their  own  credits  abroad,  oiu-  merchants  and  manufac- 
turers are  not  benefited  by  low  foreign  discount  rates, 
85518—10 2  9 


National    Monetary     Commission 

except  in  so  far  as  note  brokers,  who  make  it  a  practice 
to  borrow  in  Europe  with  commercial  paper  as  collateral, 
are  better  able  to  finance  their  purchases.  What  is  more, 
they  receive  relatively  little  advantage  from  an  accumu- 
lation of  funds  in  New  York  banks.  Low  call  loan  rates 
have  an  indirect  rather  than  a  direct  effect  on  the  rate 
which  the  mercantile  community  has  to  pay  for  money. 
Low  call  rates,  in  other  words,  are  an  indication  more 
especially  of  stagnation  in  the  stock  market  than  of  a 
lack  of  demand  for  accommodation  from  merchants  and 
manufacturers.  Such  rates  do  not  act  as  a  stimulus  to 
trade  in  general  any  more  than  high  call  rates  act  as  an 
immediate  check  to  overexpansion. 

1  It  is  ncDt;  only  in  our  domestic  trade  that  the  country 
suffers  through  the  want  of  a  discount  market.  Without 
bank  acceptances  we  are  at  a  distinct  disadvantage  in 
connection  with  our  foreign  trade.  Our  importers,  unable 
to  open  credits  with  their  banks,  as  is  done  abroad,  are 
not  in  a  position  to  finance  their  purchases  upon  as  favor- 
able a  basis  as  the  importers  in  other  countriesJLas  English 
cotton  spinners,  for  example.  The  English  spinner  about 
to  purchase  cotton  in  America  arranges  for  his  bank  to 
accept  sixty  or  ninety  days'  sight  bills  drawn  on  it  by  the 
American  shipper.  The  latter  draws  his  bills  on  the 
English  bank  and  attaches  the  documents  covering  the 
shipment,  such  as  the  bills  of  lading,  insurance  certificates, 
invoices,  etc.  He  then  sells  them  to  a  New  York  bank, 
thereby  receiving  immediate  payment  for  his  cotton. 
The  New  York  bank  forwards  the  bills  to  its  London 
correspondent,  which  presents  them  for  acceptance  to  the 
bank  upon  which  they  are  drawn.     Upon  the  acceptance 


Bank  Acceptances  in    United  States 

of  the  bills  the  documents  are  delivered  to  the  accepting 
bank,  which  then  turns  them  over  to  the  spinner  upon 
whatever  arrangement  has  previously  been  made.  The 
accepted  bills  are  discounted  by  the  New  York  bank  in 
London  and  the  proceeds  placed  to  its  credit  there.  The 
New  York  bank  can  afford  to  pay  a  high  rate  for  such 
bills,  as  they  are  drawn  on  prime  bankers,  rendering  cer- 
tain their  ultimate  payment.  The  purchase  of  the  bills 
does  not,  moreover,  necessitate  any  outlay  of  money,  as 
against  the  credit  to  be  received  through  the  discount  of 
the  bills  the  New  York  bank  can  immediately  sell  its 
checks  on  London. 

Without  such  banking  facilities — that  is,  the  ability  to 
arrange  with  his  bank  to  accept  time  bills  drawn  on  it  by 
a  foreign  shipper,  the  American  importer  is  compelled  to 
finance  his  purchases  in  either  one  of  two  ways.  He  may 
pay  for  the  goods  at  once  by  remitting  funds  direct  to  the 
shipper.  This,  however,  ordinarily  necessitates  the  nego- 
tiation by  the  importer  of  a  loan  on  his  promissory  note. 
If  he  is  not  in  a  position  to  secure  such  an  advance  he  must 
shift  the  burden  of  providing  fimds  to  finance  the  ship- 
ment, from  the  time  it  is  forwarded  until  it  is  to  be  paid 
for,  upon  the  foreign  shipper,  who  is  then  in  a  position  to 
exact  terms  more  favorable  to  himself  through  an  adjust- 
ment of  prices.  The  practice  in  connection  with  this 
method  of  making  payment  for  foreign  purchases  is  for  the 
shipper  to  draw  his  draft  on  the  American  importer  and 
turn  it  over  to  his  banker  to  forward  for  collection.  Such 
drafts,  drawn  as  they  are  on  individual  importers  and  not 
on  banks  whose  standing  is  well  known  abroad,  must  be 
sent  for  collection  since  there  is  no  general  market  for 

II 


National    Monetary     Commission 

them.  Practically  the  only  way  in  which  a  foreign  ship- 
per can  realize  immediately  on  bills  of  this  character  is  to 
dispose  of  them  to  his  own  banker  or  get  him  to  make  an 
advance  on  them. 

^  Either  of  these  two  methods  of  financing  our  imports  is 
expensive  even  when  the  time  between  the  shipment  and 
the  receipt  of  the  goods  is  short.  When  the  time  is  much 
longer,  as  in  the  case  of  imports  from  South  America  and 
the  Far  East,  the  cost  is  almost  prohibitive — that  is,  so 
great  that  we  can  not  compete  on  an  even  basis  with  for- 
eign buyers.  In  fact,  we  might  be  practically  excluded 
from  these  markets  if  a  makeshift  were  not  possible.  Our 
importer  gets  around  our  lack  of  banking  facilities  by 
having  his  bank  arrange  a  credit  with  its  London  corre- 
spondent. He  receives  an  undertaking,  called  a  commer- 
cial letter  of  credit,  giving  the  terms  of  the  credit — that  is, 
the  name  of  the  London  bank  upon  which  the  bills  are  to 
be  drawn,  the  amount  which  may  be  drawn,  the  character 
of  the  goods  which  are  to  be  purchased,  the  tenor  of  the 
bills,  and  the  documents  which  must  accompany  them. 
On  the  strength  of  such  a  letter  of  credit,  the  shipper  in 
South  America,  for  example,  is  able  to  dispose  of  his  bills 
on  London  and  thus  receive  immediate  payment  for  his 
goods.  The  local  bank  which  buys  the  bills  sends  them 
with  the  documents  to  its  London  correspondent,  which 
presents  the  bills  to  the  bank  on  which  they  are  drawn — 
that  is,  the  bank  with  which  the  credit  was  opened.  Upon 
the  acceptance  of  the  bills  the  documents  are  delivered. 
They  are  then  sent  by  the  London  accepting  bank  to  the 
New  York  bank  which  opened  the  credit  and  the  latter 
delivers  them  to  the  importer  against  his  trust  receipt. 


Bank  Acceptances  in   United  States 

Twelve  days  prior  to  the  maturity  of  the  bills  in  London 
the  New  York  bank  presents  a  statement  to  the  importer 
indicating  the  amomit  of  poimds  sterling  which  must  be 
remitted  to  London  to  provide  for  their  payment  at  matu- 
rity or  rather  a  bill  stated  in  dollars  for  the  amount  of 
pounds  sterling  drawn  under  the  credit.  In  this  purchase 
of  exchange  the  importer  makes  payment  for  his  goods. 
This  method  while  workable  is  obviously  cumbersome,  yet 
it  is  practically  the  only  one  which  the  American  im- 
porter can  follow  in  connection  with  such  imports.  It  is 
expensive  for  the  importer,  for  not  only  must  he  pay  his 
bank  a  commission  for  arranging  the  credit,  but  there  is 
included  in  this  commission  a  charge  made  by  the  London 
bank  for  its  acceptance.  Further  than  that  the  importer 
must  take  a  material  risk  in  exchange.  At  the  time  a 
credit  is  opened  the  cost  of  remitting,  say  £10,000  to  take 
up  the  bills  in  London,  might  be  only  $48,600,  or  at  the 
rate  of  $4.86,  whereas  by  the  time  the  bills  actually 
mature  exchange  may  have  risen  and  cost  him  $4.87,  or 
$48,700. 

As  a  result  of  the  inability  of  our  banks  to  finance  im- 
ports  through  the  acceptance   of  time  bills,   American 
importers  are,  then,  made  dependent  to  a  large  extent    / 
upon  London,  and  are  required  to  pay  London  a  con-  / 
siderable  annual  tribute  in  the  way  of  acceptance  com- 
missions.    This  practice  not  only  adds  to  the  importance  ^ 
of  London  and  miUtates  against  the  development  of  New 
York  as  a  financial  center,  but  it  at  the  same  time  works 
serious  injury  to  our  export  trade.     Since  time  bills  can 
not  be  drawn  on  our  banks  from  foreign  points  against 
shipments  of  goods  to  the  United  States,  there  are  conse- 

13 


National    Monetary     Commission 

quently  in  such  foreign  countries  very  few  bills  which  can 
be  purchased  for  remittance  to  the  United  States  in  pay- 
ment for  goods  which  have  been  bought  here.  In  other 
words,  under  our  present  banking  system  our  imports  do 
not  create  a  supply  of  exchange  on  New  York,  for  ex- 
ample, which  can  be  sold  in  foreign  countries  to  those 
who  have  payments  to  make  in  New  York.  This  means 
that  our  exporters  are  also,  to  their  great  disadvantage, 
made  depeii35it  upon  London.  It  riieans  that  when  they 
are  shipping  goods  to  South  America  and  to  the  Orient 
they  can  nolt,  when  they  are  subject  to  competition,  ad- 
vantageously bill  them  in  United  States  dollars.  They 
naturally  do  not  care  to  value  their  goods  in  local  cur- 
rency-^that  is,  in  thejnoneyjDf  the  country  to  which  the 
goods  are  going — so  their  only  alternative  is  to  value  them 
in  francs  or  marks  or^sterling,  preferably  the  latter,  owing 
to  the  distribution  and  extent  of  British  trade,  creating 
throughout  the  world,  as  it  does  under  the  English  bank- 
ing system,  a  fairly  constant  supply  of  and  demand  for 
exchange  on  London.  When  we  come  to  bill  our  goods 
in  sterling,  however,  it  is  at  once  seen  that  our  exporters 
are  obliged  to  take  a  risk  of  exchange,  which  is  a  serious 
handicap  when  competing  with  British  exporters.  Our 
exporters  who  are  to  receive  payment  for  their  goods  in 
sterling  must  previously  decide  on  what  rate  of  exchange 
will  make  the  transaction  profitable.  If,  in  an  effort  to 
safeguard  themselves  against  a  loss  in  exchange,  they  cal- 
culate on  too  low  a  rate  for  the  ultimate  conversion  of 
their  sterling  into  dollars,  their  prices  become  unfavorable 
compared  to  those  made  by  British  exporters  and  they 
lose  the  business.     If  they  do  not  calculate  on  a  sufl&- 

14 


Bank  Acceptances  in    United  States 

ciently  low  rate  they  get  the  business  but  lose  money  on 
the  transaction  through  a  loss  in  exchange. 

The  prohibition  of  bank  acceptances  not  only  acts  as  a 
hamper  upon  our  domestic  and  foreign  trade,  but  is  detri- 
mental to  our  banks  as  well.  It  is  the  small  country 
bank  which  is  chiefly  affected.  The  business  of  the  coun- 
try bank,  so  far  as  the  employment  of  its  funds  is  con- 
cerned, may  be  divided  into  two  classes — that  which  relates 
to  advances  to  local  customers  and  that  connected  with 
the  investment  of  its  surplus.  It  is  in  respect  to  the  latter 
that  the  matter  of  acceptances  is  important.  Under  the 
present  limitations  of  the  national  bank  act  there  are 
three  principal  ways  in  which  a  country  bank  may  render 
its  surplus  funds  productive.  It  may  deposit  them  with 
its  reserve  agent.  This  means  a  low  interest  return,  too 
low  in  fact  to  permit  of  only  a  relatively  small  amount 
being  thus  employed.  It  may  invest  in  bonds.  In  this 
way  an  increased  interest  return  can  be  secured,  providing 
a  wise  selection  of  securities  is  made,  but  it  partakes  of  the 
nature  of  speculation.  The  third  way  is  to  buy  commer- 
cial paper.  Such  purchases  give  an  ample  interest  return 
and  there  is  no  savor  of  speculation.  Even  this  method 
of  employing  a  bank's  funds,  however,  is  far  from  satis- 
factory. It  means  the  investment  in  a  security  for  the 
strength  of  which  the  bank  must  depend  on  the  word  of 
note  brokers,  the  rating  of  the  mercantile  agencies,  or  the 
opinion  of  some  correspondent  bank.  It  means,  further- 
more, the  tying  up  of  the  bank's  funds  for  a  fixed  period. 
If^  national  banks  were  permitted  to  accept  time  bills  the 
country  bank  could  then  invest  its  funds  in  paper  bearing 
the  guaranty  of  some  great_b^nk  with  whose  standing  it 

15 


National    Monetary     Commission 

is  perfectly  familiar.     Risk  such  as  now  has  to  be  taken 

1  would  be  eliminated.  What  is  vital,  however,  is  that  with 
a  national  discount  market  an  investment  in  a  bank- 
accepted  bill  is  one  which  could  be  realized  upon  immedi- 
ately. CommerciaPpaper  and  bank  acceptances  are  both 
discountable.  The  prime  difference  between  them,  as 
affecting  a  country  bank,  is  that  they  are  not  both  readily 
rediscountable.  Herein  probably  lies  the  reason  for  the 
strong  prejudice  against  rediscounts  which  exists  among 
bankers  in  the  United  States.  In  this  country  when  a 
bank  discounts  a  piece  of  commercial  paper  it  is  discount- 
ing something  which  for  its  security  depends  solely  on  its 
maker.  Should  the  bank  desire  to  realize  on  this  paper 
it  could  do  so  by  rediscounting  it,  but  such  a  rediscount 
would  be  practically  equivalent  to  a  loan  to  the  bank  on 

\  the  strength  of  its  own  name.  In  other  words,  to  redis- 
count its  commercial  paper  would  affect  a  bank's  credit. 
To  ask  for  a  rediscount  is  to  ask  for  accommodation. 

/  This  would  not  be  the  case  with  bank-accepted  bills.  If 
such  bills  were  discounted  by  a  country  bank  as  a  means 
of  investing  its  surplus  and  it  was  desired  to  realize  on 

(them  such  a  rediscount  would  be  made  not  on  the  name  of 
the  country  bank,  but  on  the  name  of  the  accepting  bank. 
A  rediscount  in  this  instance  would  not  constitute  a  loan 
to  the  country  bank  and  would  have  absolutely  no  eifect 
on  its  credit.  It  would  merely  indicate  that  some  more 
profitable  business  had  arisen  in  which  to  employ  its  funds 
or  that  it  was  desirous  of  increasing  its  reserve. 

Since  the  reserves  of  interior  banks  are  so  largely  con- 
centrated with  them  and  it  is  essential  that  they  keep  their 
assets  in  an  especially  liquid  condition,  the  prohibition  of 

i6 


Bank  Acceptances  in   United  States 

bank  acceptances  works  injury  to  the  banks  at  the  coun- 
try's financial  center,  New  York,  in  a  different  way.  It 
deprives  them  of  what  London  banks,  for  example, 
have — that  is,  a  mass  of  the  soundest  securities  against 
which  to  loan  their  money  on  call  or  in  which  they  may 
invest  their  funds  for  very  brief  periods — bills  of  exchange, 
covering  genuine  commercial  transactions,  bearing  the 
acceptance  of  prime  bankers.  Unquestionably  such  secu- 
rities as  a  basis  for  loans  are  preferable  to  stocks  and 
bonds,  but  without  them  New  York  banks  must  have 
recourse  to  day-to-day  loans  on  the  Stock  Exchange. 
Moreover,  when  the  demand  for  such  loans  is  limited.  New 
York  banks  are  forced  into  the  keenest  kind  of  competi- 
tion, a  competition  which,  as  has  been  pointed  out,  is  not 
only  of  little  benefit  to  trade  but  which,  through  the  low- 
ering of  the  money  rate,  actually  stimulates  speculation. 
Furthermore,  without  a  steady  money  rate  such  as  exists 
in  countries  possessing  discount  markets.  New  York 
banks  are  left  with  no  reasonable  or  satisfactory  basis 
upon  which  to  fix  a  rate  of  interest  to  pay  for  the  deposits 
of  country  banks.  In  London  interest  on  bank  deposits 
is  fixed  at  a  certain  percentage  below  the  Bank  of  England 
discount  rate,  usually  i  yi  per  cent — ^that  is,  a  rate  which 
fluctuates  with  the  value  of  money  and  normally  leaves 
a  certain  margin  of  profit  to  the  London  bank.  The  same 
practice  is  followed  in  all  the  great  financial  centers  of 
Europe.  With  us,  country  banks  receive  a  fixed  rate  of 
interest  for  their  deposits,  usually  2  per  cent,  the  year 
aroimd,  regardless  of  fluctuations  in  the  value  of  money. 
The  unscientific  nature  of  such  a  rate  is  obvious.  When 
the  call  loan  rate  is  high  country  banks  do  not  receive 

17 


J 


National    Monetary     Commission 

interest  in  proportion  to  the  value  of  their  deposits. 
When  it  is  low  the  New  York  banks  pay  more  interest 
than  the  deposits  are  worth.  In  the  latter  instance  the 
New  York  banks  are  forced  into  injurious  competition 
with  one  another.  They  are  in  much  the  same  position  as 
competing  railroads  were  earlier  in  our  history,  with 
results  similarly  baneful.  With  the  railroads  it  was 
worth  while  to  secure  traffic  even  at  a  losing  rate,  as  no 
matter  what  the  return  it  helped  if  only  a  little  toward 
meeting  fixed  charges.  Oftentimes  with  the  New  York 
banks  to-day  any  rate  which  they  can  secure  for  their 
money  whether  losing  or  not  is  acceptable  as  helping  to 
meet  this  fixed  interest  charge  on  bank  deposits.  To  pay 
2  per  cent  for  deposits  and  to  keep  a  25  per  cent  reserve  a 
bank  must  loan  its  money  at  2^  per  cent  to  come  out  even, 
taking  into  consideration  the  actual  expense  of  making  and 
recording  the  transaction.  It  is  better  to  loan  at  i  ^  per 
cent,  however,  than  to  let  the  money  lie  idle.  It  is  better 
to  lose  I  per  cent  than  to  lose  the  entire  2^  per  cent,  as 
would  be  done  in  case  no  loans  at  all  were  made,  clerk-hire 
being  just  as  much  a  fixed  charge  as  interest.  With  the 
amendment  of  the  national  bank  act,  to  permit  the  accept- 
ance of  time  bills,  such  ruinous  competition  would  cease. 
The  funds  of  the  banks  would  come  to  be  principally 
invested  in  trade  paper  and  stock-exchange  loans  would 
be  relegated  to  a  position  of  secondary  importance,  as  in 
London  and  on  the  Continent.  The  field  for  the  invest- 
ment of  their  deposits  would  be  greatly  broadened,  to  the 
benefit  both  of  the  banks  and  trade  in  general. 
^  To  remedy  this  primary  defect  in  our  banking  system, 
to  make  possible  the  financing  of  our  domestic  and  foreign 

18 


Bank  Acceptances  in    United  States 

trade  along  the  lines  which  have  proved  so  advantageous 
in  other  countries,  to  provide  negotiable  paper  of  a  char- 
acter suitable  to  the  investment  of  foreign  funds,  paper 
which  can  not  only  be  discounted  but  rediscounted,  to  give 
trade  the  advantage  of  bank  surpluses  accumulated  both 
in  the  country  at  large  and  in  New  York,  to  lessen  the  evils 
of  speculation,  to  afford  a  reasonable  basis  for  the  calcula- 
tion of  interest  rates  on  bank  deposits  in  central  reserve 
cities,  to  bring  New  York  into  the  circle  of  those  financial 
centers  between  which  funds  move  naturally  as  discount 
rates  rise  or  decline,  to  secure  the  advantage  of  the  competi- 
tion of  foreign  capital  for  our  trade  paper,  can  be  put  in 
the  way  of  accomplishment  by  the  insertion  of  a  paragraph 
or  two  in  the  national  bank  act.      v^ 

To  permit  bank  acceptances  would  not  require  the 
revision  of  the  entire  bank  act.  To  remove  the  barrier  to 
scientific  banking,  as  it  is  known  abroad,  no  complicated 
piece  of  legislation  would  be  necessary.  Time  only  would 
be  required  for  the  development  of  a  great  national  dis- 
count market. 

The  establishment  of  a  central  government  bank  is  not 
a  prerequisite  to  the  legalization  of  bank  acceptances  nor 
to  the  giving  of  utility  to  such  acceptances.  The  chief 
value  of  such  banks  lies  in  their  great  resotirces,  which 
enable  them  to  rediscount  bills  and  make  loans  against 
bills  or  other  securities  without  practical  limit  at  all  times, 
thus  enabling  other  banks  temporarily  to  realize  upon 
their  assets  should  occasion  require.  That  is  the  fimction 
of  a  central  bank.  If  any  bank  is  sufficiently  powerful  to 
do  this  and  is  willing  to  content  itself  with  small  profits 
through  the  keeping  of  a  large  reserve  it  can  come  to  exer- 

19 


National    Monetary     Commissto 


n 


cise  the  functions  of  a  central  bank.  There  is  no  neces- 
sity of  such  a  bank  being  the  Government's  sole  financial 
agent.  It  is  not  this  which  gives  the  Bank  of  England  its 
power.  It  is  rather  the  knowledge  that  the  Government, 
realizing  the  size  of  the  burden  which  the  Bank  is  bearing 
and  how  important  its  safety  is  to  the  whole  financial 
fabric  of  the  country,  stands  ready  to  assist  it  in  case  of 
need.  Past  crises  have  been  met  by  the  Government 
authorizing  the  Bank  of  England  to  make  an  extraordinary 
issue  of  notes.  Certainly  our  Government  can  be  counted 
upon  to  render  like  assistance  to  a  national  bank  similarly 
placed.  In  fact,  we  already  have  a  law  providing  for  an 
issue  of  emergency  notes  under  the  sanction  of  the  Govern- 
ment. 

If,  moreover,  we  are  to  judge  by  the  Bank  of  England, 
provisions  for  an  elastic  currency  are  not  essential  to  the 
existence  of  a  central  Bank.  It  is  true  that  the  Bank  of 
England  has  a  large  amount — £56,327,085  notes — out- 
standing, but  of  these  £37,877,085  are  on  account  of  the 
Government — that  is,  they  are  nothing  more  than  paper 
representing  an  equivalent  amount  of  gold,  being  exactly 
similar  to  our  own  Government  gold  certificates.  Of  the 
remainder,  £11,015,100  are  based  on  £11,015,100  govern- 
ment debt.  The  balance,  £7,434,900,  is  based  on  "other 
securities. "  This  balance,  however,  is  not  subject  to 
periodic  fluctuation.  From  day  to  day  the  only  way  the 
Bank  of  England  can  increase  its  note  issue  is  by  receiving 
into  its  vaults  an  equal  amount  of  gold. 


^ 


THIS  BOOK  IS  DUE  ON"  THE  LAST  DATE 
STAMPED  BELOW 

AN     INITIAL    FINE    OF    25    CENTS 

WILL  BE  ASSESSED  FOR  FAILURE  TO  RETURN 
THIS  BOOK  ON  THE  DATE  DUE.  THE  PE^LTY 
WILL  INCREASE  TO  SO  CENTS  ON  THE  FOURTH 

ICIrdu"!  "°  "•°°  °''  ™^  seventh"^!!; 


WAV  6  ty*, 


Mar 


8 


1938 


^  1941 


LD  21-50m-l. 


